LAW AND ECONOMICS

 

On merger simulation and its potential role in South African merger control

 

 

Liberty Mncube; Hardin Ratshisusu; Bhekithemba Dlamini

Competition Commission of South Africa

 

 

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ABSTRACT

This paper simulates the price effects of the proposed Ferro Industrial Products (Ferro) and Powder-Lak merger in order to suggest the role that merger simulation models should play in South African merger control. Merger simulation can provide support to the Commission's analysis by: focusing parties' attentions on verifiable economic arguments; making transparent the values of the key parameters and assumptions in the Commission's analysis; producing quantitative estimates of the results of a given transaction; and indicating the amount of resources to allocate to proposed merger cases. However, it offers only one piece of evidence in a case and its results must be interpreted with an understanding of the potential limitations.

Keywords: Merger simulation

JEL: L40, C15, K21

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References

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Accepted October 2009

 

 

Endnotes

1 In addition, there remains no obvious and commonly accepted simulation approach which means that it remains important to continue thinking about carefully applying the market definition approach.
2 Without understanding the limitations of such models and the circumstances under which they can and should be usefully applied, they may not just be useless, but dangerous in the sense of providing possibly spurious results with spurious claimed accuracy (see Walker, 2005).
3 The Volvo experts criticised the study for the following reasons, namely, the use of list prices, IIA property of logit type models, common parameters across countries and heteroskedasticity. Despite these criticisms, the EC concluded that even though the merger evaluation will not be solely based on the findings of this study, the results of econometric work can be a valuable supplement and add insight into merger analysis.
4 For a brief review of the Oracle/People Soft merger and the Volvo/Scania merger see Budzinski and Ruhmer (2008)
5 This was an intermediate merger transaction, which in terms of section 14(1)(b) of the Competition Act No. 89 of 1998 (as amended) the Commission takes the ultimate decision, unlike for large mergers.
6 Courtlauds was founded in the UK in 1816 and was involved in the powder coatings business through International Paint & Pinchin Johnson.
7 Case No IV/M.1363.
8 See case number IV/M.1182 (1998).
9 Case No IV/M.1363.
10 See Case No 62/LM/Jul05.
11 See Motta, M. 2004. Competition policy: Theory and practice, p: 105. Church & Ware. Industrial Organisation, p: 611.
12 The pre-merger Herfinfindal-Hirschman Index (HHI) was 3094 points while post merger it was going to be 4424 points thus yielding a change in HHI of 1330.
13 Imports are mainly from companies such as Jotun (based in Dubai), PTL and Colour Blast (based in China), Rapid Powder Coating and Nice Coatings (based in India) and Oxyplast (based in Canada)
14 For instance, one major white goods manufacturer had switched to imports but immediately switched back to the local product due to quality problems.
15 Case number: 89/LM/Oct00
16 See page 20. 'where efficiencies constitute "real" efficiencies and there is evidence to verify them of a quantitative or qualitative nature, evidence that the efficiencies will benefit consumers, is less compelling. On the other hand, where efficiencies demonstrate less compelling economies, evidence of a pass through to consumers should be demonstrated and although no threshold for this is suggested, they need to be more than trivial, but neither is it necessary that they are wholly passed on... When we talk of real economies we would, without proposing an exhaustive list, include dynamic efficiencies, production efficiencies ranging from plant economies of scope and scale to research and development efficiencies that might not be achieved short of merger. Pecuniary efficiencies would not constitute real economies nor would those that result in a mere redistribution of income from the customers, suppliers or employees to the merged entity.'
17 Put differently, some customers will stop buying product 1 if its price increases, the diversion ratio from Firm 1 to Firm 2 is the percentage of those displaced customers who end up buying product 2. This is roughly the percentage of Firm 1's marginal customers who view Firm 2 as the next best alternative.
18 Table 4 in the Appendix shows diversion ratios in the proposed Ferro/Powder-Lak merger. Mathematically, the diversion ratio is shown below;
19 The establishment of basic merger simulation procedures by Werden and Froeb (1994) and Hausman, Leonard, and Zona (1994) has led to the growth of many studies exploring the strengths and weaknesses of simulation models to merger analysis.
20 For example as cited in Stavins (1995) 'economists have employed various means of estimating demand and supply for differentiated products or individual attributes, There is still no agreement as to the best way to estimate demand elasticities for products differentiated in several attributes. ...A large number of products forces the analysts to place strong restrictions on demand to avoid estimating thousands of elasticities. In most of the studies, models are assumed to compete only with their two nearest competitors. However, a sufficient drop in price could presumably make consumers move to a different market segment, making the assumption too stringent. Cross-elasticities are often estimated only after the market is aggregated to two general types of products.'
21 It is noted that products are differentiated because consumers perceive differences in the products. Included are instances where two products may be physically identical, and yet significant numbers of consumers are prepared to pay more for one than for the other. This scenario can arise where products are strongly branded, possibly through advertising, and consumers form preferences for one product over another, perhaps for intangible product characteristics such as image or reputation. Another product characteristic that can be varied, and hence can cause differentiation, is the geographical location of outlets.